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The Twisted Economics Of Harry Potter

July 01, 2007

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Call it the curse of Hogwarts. It turns out that--at least for some in the wizarding world--it's tough to make money out of magic. Harry Potter has fans clamoring in excitement as the seventh and last book in J.K. Rowling's hit series, Harry Potter and the Deathly Hallows, lands worldwide on July 21. With the fifth movie due out in weeks and the recent announcement of an Orlando theme-park attraction that could cost half a billion dollars, Pottermania is at an all-time high.

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But what should be a pot of gold for Harry's business partners is turning into an empty cauldron for many of them. The most successful literary brand in recent history has made its author a billionaire, but others have not fared so well. Retailers, spellbound by the chance to reach millions of Potter-obsessed customers, are cost-cutting for market share to the point where many stand to lose money. For book publishers, the tsunami distorts results in Potter release years, creating wild share-price swings and a distraction from other parts of the business. Even Warner Bros. Entertainment Inc. (TWX), which has made billions off the Harry Potter movies, saw sales and profits drop last year and in the first quarter without a fresh Potter offering in the mix.

For booksellers, the source of the pain is mammoth retailers like Amazon.com (AMZN), Wal-Mart (WMT), and Britain's ASDA chain, which have slashed prices by 50% to woo fans. "It's like being in the trenches with the bullets flying over you," says Sonia Benster, owner of The Children's Bookshop in Huddersfield, England. Amazon.com CEO Jeff Bezos concedes that the company won't make a profit from the new Potter book. But he told shareholders that it has racked up more than 1 million pre-orders so far--and, Amazon hopes, plenty of new customers who will buy other books. Because of such struggles for a piece of the Potter pie, notes Simon Fox of Britain's HMV Group PLC, owner of the Waterstone's book chain, it's "hard to make money."

Independent booksellers can't even begin to compete on that scale. While many plan to fight back with special midnight parties--in the belief that it's no fun to wear a wizard hat in Wal-Mart--others are just opting out of the frenzy. "I won't be open at midnight," says Bonnie Stuppin of San Francisco's Alexander Book Co. Instead, she'll personally drop off copies to a few customers at no extra cost between midnight and 6 a.m. "It's sad that what little profit the industry can make off Harry Potter is being stripped away," says Stuppin. "If I ran my business that way, I wouldn't be here." Some booksellers who helped launch Potter in America, hosting signings with Rowling when she was starting out, are disillusioned. "In the beginning it was great for us, but the discount has become more important," says Valerie Lewis of Hicklebee's in San Jose, Calif. To Peter Glassman, owner of Manhattan's Books of Wonder, selling Potter below cost is "analogous to downloading music and the impact that has on music stores."

Potter's two publishers, which have sold more than 350 million copies worldwide, face a different set of perils. Scholastic Corp. (SCHL), which has U.S. rights, will never speak ill of the boy wizard whose last book accounted for 8% of revenues and an estimated one-third of profits in the fiscal year that ended in May, 2006. It's planning a record 12 million print run this time. But analyst Drew Crum of Stifel, Nicolaus & Co. (SF) says the children's book division often does better in off-Potter periods. "The company tends to lose focus in a Harry Potter release year," says Crum. "They extend so much energy on one title," he adds, and not enough on fixing things like the company's flailing direct-to-home book business. Although there has been the usual pre-Potter run-up in the stock, Scholastic's share price is below where it was five years ago. With the Harry franchise about to end, Scholastic is focusing on share buybacks, international expansion, and repairing weaker parts of the business. And the company says backlist editions of Potter could generate tens of millions in sales each year.

Few face as gaping a hole with Harry's exit as its original publisher, Bloomsbury, which holds all rights to the titles outside the U.S. Last year, while the world waited as Rowling said she was working away on Book 7 in Scottish caf?s instead of her multiple homes, the publisher's profits collapsed by three-quarters, to $10.3 million, as revenues fell almost a third, to $148.6 million. Spooked at the prospect of a one-trick pony, investors have sent Bloomsbury's share price down about 40% in the last year--even as a guaranteed hit is about to reach store shelves.

Now with Britain's biggest bookmaker taking bets that Harry will get killed off in the last installment, the possibility looms that the figurehead of this brand won't even be "alive" soon. That could be a real drag for General Electric Co.'s (GE) Universal Parks & Resorts, which beat out rival Walt Disney Co. (DIS) to build "The Wizarding World of Harry Potter" with Warner Bros. in its Orlando Park by late 2009. While it won't disclose the size of the investment, International Theme Park Services consultant Dennis Speigel predicts they could easily spend $500 million to get it right. The specter of a dead Harry could dampen some of the fun. But Universal Parks Chairman and CEO Tom William says the 20-acre attraction is "going to be a game-changer" and pledges to do "the biggest and best job on this as on any job we've ever taken."

In any case, it's easy to understand why the Potter brand is so seductive. Warner Bros. (TWX) pumped out some disappointments last year, such as the thriller Lady in the Water, helping push movie revenues down by 17%. But Potter brings the magic all back. The company has made billions off the franchise and stands to make billions more as it rolls out movies and DVDs in the coming years. Unlike bookstores, movie theaters don't slash admission prices when a new Potter film comes out. That said, the $974 million worldwide box office gross for the first Harry Potter movie (Harry Potter and the Sorcerer's Stone) stands at 9% more than the $895 million gross for the most recent film in 2005, Harry Potter and the Goblet of Fire. And that's amid rising ticket prices.

Even if Harry Potter leaves a trail of profit-starved vendors and Potter-addicted producers in its wake as the series wraps up next month, the infatuation is unlikely to die. That's what Emerson Spartz, founder of the popular fan site MuggleNet.com, is betting on. Spartz, a University of Notre Dame sophomore who launched the site in 1999 at the age of 12, gets more than 1 million hits a day. He's now pulling in "a six-figure income" from ads and his best-seller, MuggleNet.com's What Will Happen in Harry Potter 7. He hopes to mimic the fan base that's grown around The Lord of the Rings and has no plans to close down the site. "There will always be people who get into Harry Potter fresh and want to meet other new Harry Potter fans," says Spartz.

By Diane Brady, with Kerry Capell in London and Joshua Vittor in New York